By: Gunjan Bhardwaj
There are many different types of innovation, but business model innovation shows the strongest correlation with increased operating margin. Focus on Business Model Innovation is the first in a series of five articles by Gunjan Bhardwaj, head of Ernst & Young´s Global Business Performance Think-tank. The topics of the other articles are: Disruptive Innovation; Innovation in Networks; Social Innovation; and the Impact of Location on Innovation.
Achieving long-lasting competitive advantage has become increasingly difficult in today’s unpredictable business environment. This high pace of change has brought new, exciting business ideas, and has led to the reinvention of already existing business models as well. Business model innovations can come from new entrants, but incumbent firms can also reinvent their business model to stay competitive and to outperform competitors.
First, what is a business model? A business model can be defined as the combination of “who”, “what”, “when”, “where”, “why”, “where”, and “how” a company provides its customers with its products (Mitchell & Coles, 2003: 16). In fact, the business model includes as main components the core strategy, the strategic resources, the customer interface, and the value network. Customer benefits, the configuration of competencies, and the company boundaries are acting as intermediaries between the four components (Hamel, 2000).
Business model innovation is thus the discovery of a totally new way to do business in an already existing business
Creating a new business model means to discover new sources of revenues, thanks to new technology, changing demographics or consumer behaviours (Hamel & Skarzynski, 2001: 65). Business model innovation is thus the discovery of a totally new way to do business in an already existing business.
This type of innovation does not discover new products or processes, but rather leads to the redefinition of an existing product, and of the way it is provided to customers. However, to be considered an innovation, the new business model has to either attract completely new customers to the market or to urge existing customers to increase their consumption.
By definition, business model innovation is often incompatible with the company’s traditional way of doing business, and both are most of the time conflicting (Markides, 2006: 20).
Why is business model innovation so important?
According to the IBM Global CEO Study 2006, for which 765 CEOs and executives were interviewed, of 3 innovation types –products, operations, and business models- business model innovation, across all industries, shows the strongest correlation with operating margin growth (IBM, 2006: 3).
Companies which are not continuously innovating will not survive
More importantly, in an era of fierce competition and high innovation, strategy life cycles have never been so short, and companies which are not continuously innovating will not survive. In fact, business model innovation could very well become the only way to deal with the discontinuous pace of change (Hamel & Skarzynski, 2001: 65).
Reinventing and creating business models provides a competitive advantage, which is essential to survive in such an environment. Indeed, the environment, socially, technologically, and economically speaking is currently very challenging for stable business models.
The main drivers of these frequent changes include privatisation, technological improvements and globalisation, for instance. All these shifts have led to the restructuring of industries and to the emergence of new sources of competitive advantage. Adapting to this new environment, through business model innovation, is thus of utmost importance (Voelpel et al., 2004).
The most effective firms were making important business model shifts every 2 to 4 years
According to the observations of Mitchell and Coles, who have studied several successful public companies, the most effective firms were making important business model shifts every 2 to 4 years. Continuing business model innovation is essential because it can help any company to prosper, since it can surpass incumbents’ advantages and size (Mitchell & Coles, 2003: 15-18). Firms should learn to cannibalise their own businesses before the competitors do.
Firms should learn to cannibalise their own businesses before the competitors do
In addition, when a firm changes several aspects of its business model, thus making the business model innovation very hard to duplicate by competitors, it can benefit from a significant growth and increasing profitability (Mitchell & Coles, 2004).
Amazon is a business model innovator that attracted new customers through the introduction of a new business model, thus enlarging the book market. Through the online distribution of books, Amazon did not invent any new product, but truly redefine what bookselling is all about: what the customers get out of it and how it is provided to them. In fact, Amazon created a new way to compete in the book retail industry (Markides, 2006: 20).
As mentioned earlier, a new business model can hardly coexist with the existing one. Therefore, in 1995 Charles Schwab set up its disruptive online brokerage venture as a totally independent entity. Online trades were priced around $30, whereas the average price of trades executed through office-based brokers or telephone in the mainstream organisation was $70.
Since then the mainstream business has been incorporated into the venture (Christensen & Raynor, 2003: 198). Schwab managed to establish a powerful position in the online brokerage industry and today it controls around 30% of all stock trading taking place on the Internet (Hamel & Skarzynski, 2001: 65-66).
Starbucks did not disrupt established cafés at the low end of the market. Rather, they went right into the middle of the market and disrupted sit-down restaurants and cafés with their business model innovation, offering to customers a place where they can sit and discuss, or hold an informal meeting, quickly and without spending much money (Christensen, 2007).
The idea was to make Starbucks more than a coffee retailer: to make it a comfortable destination between home and work. Starbucks offers a “community”, a shared experience. Indeed Starbucks’ new business model changed customers’ expectations of a coffee retailer (Edersheim et al., 2007: 84).
Why do companies fail to reinvent their business model?
The main hurdle business model innovation faces is the fact that it is almost always conflicting with the traditional business model of the company and requires a totally different value-chain. Therefore, incumbents are often hesitating when it comes to adopting a new business model (Markides, 2006: 21).
Commitment to the existing business model … can lead to the failure of the company
Indeed, commitment to the existing business model, established routines, and industry orthodoxy often can prevent the company from reinventing its business model and ultimately can lead to the failure of the company. Because of their hesitation to destroy their business model, which brought them success in the past, incumbents can become cumbersome (Voelpel et al., 2004).
The reticence of established firms, especially of successful ones, is quite understandable: they don’t want to change the recipe that brought them success in the past. Nevertheless, the key is to recognise that focusing on these past achievements is blinding the company and preventing new ways of doing business, which would bring new wealth, from emerging (Hamel & Skarzynski, 2001).
About the author
Gunjan Bhardwaj is coordinator of the Global Business Performance Think-tank of Ernst&Young. He is also the solution champion for Pricing strategy and effectiveness as well as Innovation management in the advisory services of Ernst & Young with a focus on Pharmaceutical and FMCG sector.
Gunjan is also a guest professor for Growth and Innovation management at European Business School (EBS) in Germany and a member of the scientific advisory board of Plexus Institute in the US which researches on complexity in health sciences
Gunjan Bhardwaj graduated from Indian Institute of Technology Bombay, India in Metallurgical Engineering and Material Sciences and then did his MBA in International Management and Marketing in Pforzheim University, Germany on a DAAD Scholarship.
Gunjan has published a number of papers and articles in various Journals and magazines and has been a frequent speaker in conferences on marketing and innovation related topics. He is also the chief editor of the quarterly journal of Ernst & Young’s advisory practice called Performance.
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